low(ish) risk house savings question

[edlong266]

Hi,
My wife and I have zero debt. We currently save 15-18% towards retirement. I'm in the Air Force and have about 10 years until my 20 year retirement. Our plan is to get out and try to pay cash for a house. We don't own one now, and don't plan on buying until we're done with the military.

We should have an extra 1K-2K per month to put away towards a house for the next 10 years. At the end of the 10 years, I want to be able to take that cash and buy a house outright. I know Dave is a fan of the growth mutual fund (which we both have for our IRAs) but I'm not sure where I should put this house savings money. Any ideas? Money market acct, CD, traditional savings account, etc? I don't want to accept much risk...which is why I am hesitant to put it in a growth mutual fund that can fluctuate with the market.
Thanks!

[mateosbaby]

I'm not a risky person, either. So if it were me in your situation, I'd go with a CD. It earns better interest than a traditional savings account, but you can't touch it for a certain number of years. You could do a 10-year (or a 5-year and see where you're at). The longer you leave it in there, the higher interest you're earning (at least at my bank).

[Greebo]

For more than 5 years, personally if it were me, I would look for good growth stock mutual funds with a LONG LONG history of good performance and overlook the more recent downturns.

Looking at one specific fund I own - TWCGX - American Century Investments Growth Fund Investor Class. The performance since it's inception in June of 1971 has been 12.56%. It's 10 year rating has only been 0.92% - but if you look at S&P 500 index funds that are at least as old, their 10 year returns are comparable - and worse as often as not - so NOBODY has done well in the last 10 years, thus why I say ignore that period. In the last 5 it's been at 4.93% and in the last 1 year 17.64% but I ignore such short term returns as well.

So imagine for a moment that you took your average $1,500 a month or 10 years and set it into a CD returning market average compared with a mutual fund such as the one I'm using.

5 year CDs return about 2.5% - so 10 years of $1,500 a month at 2.5% per year is going to give you $204k at the end of that period.

If you take a risk and use a mutual fund, your highs and lows work out like so:
Low - using 10 year return - $188k
Middlin: 5 year return - $232k
High: inception return - $356k
Not gonna happen - 1 yr return - $485k

The challenge with mutual funds is patience - you need to buy them regularly over time and then HOLD THEM - not panic and sell them when the market burps like it did over the last 2 years. I know people who lost tons because they SOLD LOW, while we rode it out and are back where we started now.

So if it were me, yes, I'd go with mutual funds. I think the risk is worth the potential gain. I wouldn't put it all in ONE fund mind you - diversification is key to security, risk is key to profit.

[a.nonymous]

If you take a risk and use a mutual fund, your highs and lows work out like so:
Low - using 10 year return - $188k
Middlin: 5 year return - $232k
High: inception return - $356k
Not gonna happen - 1 yr return - $485k

This. And that's not even taking the dollar cost averaging effect into account.

[InTheMoon]

If you were interested in using CD's, you could do a CD ladder. You could set it up to buy CD's in $5,000 or $10,000 increments. Once you'd saved $5000 you'd buy a 1 year (or whatever time frame appeals to you) CD. Then in 5 months (saving $1000/month) buy another 1-year (or, again, whatever time period) CD. And so on and so on. This will allow you to get better interest rates when they are available to you and also give you the ability to dictate the amount and time frame of each CD.

[Greebo]

This. And that's not even taking the dollar cost averaging effect into account.

Well, it is - because my calculations are based on an average ROI with monthly contributions of $1,500.

[a.nonymous]

This. And that's not even taking the dollar cost averaging effect into account.

Just to re-iterate that point again:

Taking pure performance values, based on S&P500, on an annually fixed investment of $12000 (annual because I do not have more detailed data).

The S&P500 ended 2000 at 1320.28
In 2010 it ended at 1257.64
The growth was basically -4.75% for those 10 years.

If you had invested 12,000 at every end-of-year point along the line, your total return on 120,000 invested would have been roughly 9% easily beating the overall performance of the market.

2.5% CDs would have beaten that fair and square (growing roughly to $150,000), however, do keep in mind that that 10 year period was exceptionally bad.

The average 10-year return for the past 40 10-year periods (using data going back to 1960) in the S&P500 index has been about 118% after all.

[a.nonymous]

Well, it is - because my calculations are based on an average ROI with monthly contributions of $1,500.

touche.

[edlong266]

Thank you all for the great advice. I still haven't made up my mind but this gets me going...

[scottp999]

For a portion of your house nest egg, you could also consider building a CD ladder as part of a diversified approach.

If you think interest rates are about to rise since they have been at historical lows, invest heavy on the short duration now and buy longer as you see them move up to more acceptable levels. This is what the largest bond fund (Pimco) is doing right now. They have moved completely into cash equivalents (durations of 3 months or less in US Treasuries). Bill Gross who runs Pimco is notorious for front running the Federal Reserve and being in the know.

Many speculate (take that for what it's worth) that when QE2 ends in June. interest rates will rise dramatically because the Federal Reserve has been buying a large amount of the Treasury auctions from the the primary dealers. Interest rates rising would give the Federal Reserve cover to do additional quantitative easing. People want to buy bonds/CD's during that interest rate pop, so that is why they are keeping a lot of short term paper including cash (instant maturity) around at the moment.

Others feel the Fed's balance sheet is so large now that they can stealth QE (monetize the debt) just based on the interest turn over on their balance sheet assets.

I agree with others that diversification is key. Diversification in multiple asset classes, not just within stock market mutual funds.

The real wild card is the purchasing power of the dollar on your time horizon, as well as the specific asset you are looking to purchase outright (house). You have the wind at your back with housing supply and if interest rates rise, or fannie and freddie are re-organized, prices will most likely move in your favor.

These markets are a rigged game now. Be ever watching and protect yourself on the downside, use multiple asset classes to hedge. It is not a buy and look at your quarterly statements type of world any more.

“The markets were once non-profit organizations run for the benefit of investors, and the people that worked there and actually traded there. Now it is a for profit operation that, basically is willing to sell their souls out to the highest bidder. So all of these co-located servers the hedge funds are putting at the exchanges in order to get a millisecond advantage over everybody else, it gives them the ability to sniff orders before they go to the market, allows them to front run investors. These guys are literally pulling billions and billions of dollars out and that profit doesn’t come out of thin air, that profit comes out of the actual investing public…these people are stealing money from the investing public and it is really a great tragedy”.

-Barry Ritholtz, February 15, 2011 on the Keiser Report Episode 121

Good luck.